DATE: SEP 20 1988
TO: Source Deduction Non-Resident Tax Section Head Office
Attention: Gaetan Cardinal
FROM K.B. Harding (613) 957-2129
SUBJECT: XXXX
This is in reply to your memorandum of March 31, 1988 concerning the treatment of "option, payments" made by XXXX to U.S. residents.
Based on the above facts and a review of the documentation submitted, it is our view that the payments made to the non-residents constitute option payments for purposes of the Income Tax Act (Act). Accordingly, subsection 49(1) of the Act would be applicable to such situation and the grantor of the option would be deemed to have disposed of the asset on the granting of the option. In our view it would be reasonable to consider that the proceeds of disposition be equal to the present value of the amounts to be paid by XXXX over the ten year period. In accordance with subsection 49(1) of the Act the adjusted cost base to the grantor of the option will be considered to be nil. In addition, the grantor of the option will be denied the reserve permitted under subparagraph 40(l)(a)(iii) of the Act by virtue of subparagraph 40(2)(a)(i) of its Act. The resulting capital gain may be taxed in 1987 pursuant to paragraphs 115(l)(1)(a) and (b) and subsection 115(3) of the Act. Since both the payer of the option payments XXXXXXXX and the XXXX are located in Canada you should have a problem of collecting the tax raised on the disposition of the option by a non-resident of Canada.
It is our view that the option payments cannot be considered as interest payments unless you can show that the property has already been sold to XXXX and that the company is making interest payments to the non resident rather than option payments for the right to purchase the XXXX as provided in the option agreement. We have assumed that the parties are operating at arm's length and that the option price reflects the fair market value of the XXXX
We trust these comments will assist you in responding to the Quebec District Office.
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate . Legislative and Intergovernmental Affairs Branch